When should you start a pension?
A simple answer is ‘as early as possible’ but is that correct? Jason Witcombe explains.
There is a general misconception that retirement planning means paying money into a pension. But really, the key to a financially secure retirement is simply having enough money and to an extent it doesn’t really matter whether it is in a pension, an ISA, an investment portfolio or even cash under the mattress. Although we wouldn’t recommend the latter!
“Your employer pension contributions is basically free money and well worth taking advantage of”
An Englishman’s home is his pension
In addition, paying down a mortgage is just as valid a way of saving for retirement but many of us forget to think of it in this way. The sooner you can get your mortgage paid off, the more spare income you will have from your monthly pay cheque to put into pensions and other investments.
So, try to think of pensions as just one part of the retirement jigsaw. Pensions have some quite quirky tax breaks for certain groups of people so if you can figure out where you stand with those and you can use the rules to your advantage, the more bang you will get for your buck.
Free money from your boss
The first place to start should be to double check how your employer-sponsored pension works, if you have one. On top of the standard level of contributions, many employers will match any payments you make up to, say, 5 per cent or 10 per cent of salary. That’s a fantastic benefit (free money basically) and well worth taking advantage of.
Take some time to acquaint yourself with what is on offer. Speak to your HR department as a priority as we have met a number of people who have missed out on free pension contributions from their employers purely because they weren’t aware of what was on offer.
Greater tax relief
The most efficient way of saving into a pension is to receive a high level of tax relief on your contributions but to only pay basic rate tax on your retirement income. The top rate of income tax is 45 per cent for those earning over £150,000 but someone earning £41,450 or more can get 40 per cent tax relief. That means that it only costs £60 out of net pay to get £100 into a pension.
In fact, there are groups of people who can get even greater tax breaks. Income between £100,000 and £118,880 effectively suffers 60 per cent income tax which can be mitigated through a pension contribution.
Also, where a household receives Child Benefit and the higher earner brings home more than £50,000 p.a. they would start to lose the Child Benefit but a pension contribution can help you retain it. As Child Benefit is paid per child, the more kids you’ve got, the greater the benefit of the pension!
What puts some people off pensions is that you can’t draw benefits before age 55. That might not be a problem if you are 45 but if you’re in your 20s, that’s a long time to have money tied up. This is therefore a good reason to adopt a multi-faceted approach to retirement planning.
Separate your eggs
As with everything in life, it’s best not to have all of your eggs in one basket and to try to look at the bigger picture when creating a financial-planning strategy. It might seem counterintuitive to delay pension contributions – the normal story is that you should start early to benefit from year on year of rolled up returns – but such a strategy can work really well in certain circumstances.
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